Escape From Negative Japan Rates Wrecked by Record Hedging Costs

  • Swap premium for yen holders reaches record 102.5 basis points
  • Basis swap jump `is an extremely serious problem,' says Mizuho

The Bank of Japan’s negative interest rate policy is making it more expensive for domestic banks to hedge dollar investments, threatening to slow their escape from negative rates into U.S. currency debt.

When securing dollar funds for overseas investments, Japanese financial institutions often use trades that involve swapping greenback and yen interest rates, instead of taking on exchange rate risk by trading currencies. The premium for yen holders to borrow dollars for five years reached a record 102.5 basis points last week, and was 97 on Thursday.

BOJ Governor Haruhiko Kuroda’s negative-rate policy will accelerate a hunt for yield among Japanese banks that boosted overseas lending by $360 billion in three years to $3.56 trillion as of September, Bank for International Settlements data show. Surging funding costs may force them to make riskier investments to sustain returns, according to Mizuho Financial Group Inc.

“The jump in basis swaps is an extremely serious problem,” said Hidetoshi Ohashi, the chief credit strategist in Tokyo at Mizuho. “If it continues widening, financial firms will need to reduce their overseas holdings or diversify their investments into other regions.”

Japan’s three megabanks -- Mitsubishi UFJ Financial Group Inc., Sumitomo Mitsui Financial Group Inc. and Mizuho -- won’t see much impact from the rising basis swaps because they can raise dollar funds by selling bonds overseas, according to Yoshinobu Yamada, a senior analyst at Deutsche Bank AG in Tokyo.

“Investors such as life insurers will have problems when they want to put their money in foreign bonds if costs are rising,” Yamada said. Mizuho’s Ohashi said Japan’s regional banks will also be affected.

Domestic life insurers’ holdings of foreign securities rose 4 percent last year to 76.7 trillion yen ($681 billion), even as they decreased the domestic debt they owned, according to data from the Life Insurance Association of Japan.

An alternative destination for Japanese money may be the euro area, where the European Central Bank lowered negative rates further last week, according to Mizuho’s Ohashi. The premium for yen holders to borrow the single currency until 2021 was 45.5 basis points on Thursday, less than half the cost to secure dollars.

“There are expectations that interest rates might fall further in Europe,” Ohashi said. He said that investors will be interested in bonds of the region’s banks that offer decent extra yields.

Japanese life insurers are stopping sales of insurance products that double as savings vehicles because of their falling returns, according to Tatsuo Majima, an analyst at Tokai Tokyo Financial Holdings Inc.

“It’s a painful thing for life insurers that their returns on foreign investments are falling,” Majima said.

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